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Gold Must Move now or Suffer Consequences

Our headline says it all as far as the current state of the gold market. Gold has idled in a net sideways pattern now for nearly an entire year. Technically, this consolidation can only mean one of two things: accumulation or distribution. If the former, we can expect an eventual upside breakout and the beginning of a new uptrend. If the latter, we will see further erosion, probably characterized by a liquidation sell-off, especially if the summer lows at the $275/oz. area fail to hold.

The battle is pitched and the fighting has been fierce among gold's loyal supporters and its bitter enemies. Gold's most eloquent defenders argue for a higher gold price based on its 18-year bear market, which they argue cannot possibly go any further, and on fundamental factors such as the supply/demand ratio and the coming Y2K computing crisis. Its foes argue that gold is a "barbarous relic" that has outlived its usefulness as a monetary unit and storehouse of wealth. Which side will be proven correct? One thing is for certain: we will know very shortly.

So which way will gold ultimately decide to move? We do not pretend to know the answer to that question—only the market itself knows for certain. All we can do is rationally analyze, as far as possible, the market from both a technical and fundamental perspective in order to gain insight into what the future may hold. And when we weigh those various factors we arrive at a less than satisfying conclusion.

On the positive side, gold has etched out what appears (and the operative word is "appear") to be an inverse head and shoulders pattern. This is known in technical parlance as a bottom reversal formation that generally portends a rise in the market. In this case, the "head" has found support near the $270/oz. level while the two "shoulders" are each resting at approximately the $290/oz. mark. The "neckline" lies at approximately $300/oz. If this pattern is valid, we can expect no less than a rise to $330/oz. based on the minimum measuring implications of the H&S pattern (which is derived by measuring the difference in price between the "head" and the "neckline"—in this case a $30 difference—and adding that number onto the neckline. Thus, $30 + $300 = $300).

As far as we know, we were the first newsletter writer to point this out and several others have since followed suit (and you read it here on Gold-Eagle first). There is no denying that the H&S pattern itself on gold's daily and weekly chart is valid from a pictoral viewpoint—in fact it is textbook perfect. But one problem remains: such a pattern cannot properly be called an "inverse head and shoulders" pattern until an actual reversal occurs. In this case, we need to see an upside penetration of the neckline at $300/oz. by at least 3% in order for this pattern to remain valid. To date, that has not happened (though it still could).

Disconcerting is the fact that volume action in the gold futures market has been less than spectacular of late. In fact, it has been downright pathetic. In a consolidation market, such as gold is presently in, this is not necessarily a bad thing. But on those days when gold has attempted to rally above $300, volume was usually lacklustre. Conversely, on those days recently when gold's price has fallen, trading volume has been rather high. This means volume is chasing price declines which normally points to extreme selling pressure.

The XAU gold/silver index seems to be reflecting this bearish trend and we interpret its chart as pointing to a continued decline in the gold market in the weeks ahead. It looked for awhile that a head and shoulders bottom pattern was forming but it now appears the pattern was completely invalid and the falling trend is recommencing. Most recently, a bearish flag pattern has appeared in the XAU and this forecasts an XAU price of below $60 (from its current $65.89) in the very near future.

Even worse for gold is the fact that the CRB commodities index, a price basket of 17 different commodities (including gold), has fallen below a 22-year chart support and now stands at levels unseen since 1976. Chart support is not for a long way down in the CRB and this points to a massive deflationary collapse in the overall commodities sector. And since gold is extremely sensitive to deflationary pressure (indeed, it is one of the best barometers for measuring inflation or deflation) gold stands to suffer from a commodities collapse, at least initially. Watch this index very closely. If it continues falling in the days ahead, an outright sell-off will likely develop which would almost certainly lead to a liquidation in the global gold market (gold is always the first thing to be sold in a crisis because of its extreme liquidity). When this happens, we could easily see a gold price of below $250/oz. or even lower.

However, this is the good news we've been waiting years for. That's right—for true gold bugs, nothing could be better, especially if you are in a financial position to be able to capitalize on this literally once-in-a-lifetime opportunity. When (if) gold collapses to these considerably lower levels you must begin accumulating immediately at the extremely low prices. This is how fortunes are made.

John D. Rockefeller, the great oil magnate, augmented his vast fortune when oil, much like today, was suffering from extreme weakness and deflationary pressures. During one of the periodic price collapses of his time caused by overproduction, he urged his colleagues to take advantage of the low price and purchase aggressively, stashing the oversupply in inventory to wait for a better day. "We must try and not lose our nerve," he said. "We will surely make a great mistake if we do not buy." We believe that same wisdom is just as applicable to today's gold market.

In summary, while a reversal of trend to higher price levels is still a possibility, we are leaning toward a bearish scenario in the gold market with general commodities deflation carrying gold to much lower levels. However, we want to reiterate our stance that 1999 will be the last year of gold's long-term bear market. Investors should begin accumulating now, and especially if gold's price collapses, in anticipation of the next bull market.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy. The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment. He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.